Answer ONLY ONE out of the two questions in this section
(a) Present a model of the labour market and use its equilibrium to derive an aggregate supply relation of the form y, = y * +8(p, where 0 < B <1, y, is the level of output, y * is the natural level of output, A is the price level — all measured in natural logs — while is the expectations operator.
(b) Explain the mechanisms that underlie the relation between price level and output in aggregate supply. Illustrate the relation diagrammatically and then show and explain the impact of a reduction in the expected price level.
(c) “Can a permanent/anticipated change in monetary policy affect output?” Provide an analysis that addresses this question, by combining the aggregate supply relation, with an aggregate demand relation of the form y, = m, — p,, where m, is the supply of money.
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